Making Bad News Pay

David Tice has a reputation for analyzing anything that comes his way. Ask
15-year-old daughter Abby. When she was five, her father helped her set up a
lemonade business–after a lot of analysis. Abby set up her lemonade concession
on Saturdays along the bike trails. Little wonder that she ended up making more
pennies than most other kids in her neighborhood.

The analysis Tice gets paid for earns him far less adoration than he got for
his lemonade advice. Tice is a professional stock-market bear. He writes
scathing research reports, which he sells to institutional investors, detailing
why the stocks of some companies could be headed for a fall. He also runs a
mutual fund called the Prudent Bear that sells stocks short. While the typical
investor wants to buy low and sell high, short-sellers do the opposite,
borrowing stock and selling it at a high price and then buying it back cheap
after the price falls.

His research is getting more popular, too. His client list has increased 40%
in the last three years, to 200 people. He takes pride in being a reality check
on Wall Street analysts, who are coming under fire for producing overly positive
research to boost their investment-banking business. "I feel particularly
responsible about warning people that there’s a cliff down below, and Wall
Street will never say that," he says.

Gobbledygook

Despite the stock market’s decline over the past 18 months, he thinks there’s
still a cliff ahead. About 75% of his investments are short bets, he says. Among
favorite targets these days are top tech players, including Amazon.com, Yahoo!,
Dell Computers, and eBay. He thinks some, including Dell and eBay, are good
companies that are simply overvalued. For example, he says analysts have been
egging on investors to buy Dell stock at a lofty 35 times their estimate of 2003
earnings. He calls the estimates "gobbledygook" because a price war
among PC sellers will hurt profits. By contrast, he thinks Yahoo still needs to
prove it has a legitimate business beyond being an Internet portal dependent on
online advertising. Many continue to consider Yahoo a strong growth company, but
Tice calls its operating performance "horrific," with 2001 revenues
likely to be 35% below last year’s. "If it’s a growth company, how come
it’s more cyclical than General Motors?" he questions. Yahoo didn’t
return calls seeking comment.

Tice finds his targets by playing the role of a sleuth, going over balance
sheets, income statements, and cash-flow statements with a fine-toothed comb. He
looks for misleading numbers or bogus information that, once uncovered, will
cause a stock to tumble. His analysis is almost always the opposite of Wall
Street’s. But critics argue that Tice sometimes overreaches.

No question, the late 1990s were rough years for Tice. As the bull market
galloped ever higher, Prudent Bear was hit with negative returns of 34% and 23%
in 1998 and 1999. Tice, like many others, kept guessing that stocks were
overvalued only to see them rise higher. Many shorts closed shop, reducing the
field from 25 managers in 1990 to six at the end of the decade, according to
Harry Strunk, a Palm Beach investment consultant who tracks short-only managers.

Sanity Check

Whether Tice is right or wrong about a stock going down,
clients value his insights. Monica Graham, a partner at the New York hedge fund
Graham Partners, thinks Tice is one of the most talented analysts she has ever
worked with. "For me, he is a sanity check at a time when it’s easy to be
swept away by all the euphoria," she says.

Consider his research into Amazon.com. Tice wrote his first
negative report on the company in October, 1998, arguing that its business was
flawed because it hadn’t shown the ability to translate rising sales into
profits. The stock continued to soar in 1999. Finally, last year, Tice made
money shorting Amazon as its stock fell 80%.

He’s still not convinced of Amazon’s business. He blasts
the pro forma earnings reported by the e-tailer as "nonsense" that
suits the company more than investors. While the company also reports financial
results under standard accounting rules, it highlights pro forma earnings that
exclude many expenses. Tice also points out that Amazon’s growth in its core
business of books, music, and videos has slowed to a crawl, and it now
emphasizes its faster-growing consumer electronics business. He calls it a
classic case of "Don’t look over here, look over here." He also says
that CEO Jeff Bezos has sold 1.1 million shares in the last three months. Amazon
spokesman Bill Curry says that Bezos has sold only 2% of his holdings to
diversify his portfolio and still owns 32% of the company. He added that pro
forma earnings are widely accepted.

One short position that Tice has regularly lost money on is
America Online, now AOL Time Warner. In 1994, Tice released a report questioning
the validity of the business, especially in the face of increased competition.
"I miscalculated the power of the brand and the customer’s loyalty,"
says Tice, who has an AOL account himself. That doesn’t mean he has quit: Tice
still believes that AOL is overvalued. One reason is that Internet use may be
slowing. As evidence, he cites a study by researcher Telecommunications Reports
International Inc. that shows US households with Net access dipped for the first
time ever by 0.3%, to 68.5 million in the first quarter. Another reason is AOL’s
accounting. The company reported that free cash flow, which usually comes from
operations, was $651 in this year’s first quarter. Tice figures it was only
$70 million after the cash settlement of a lawsuit related to the sale of Six
Flags Theme Parks and several other one-time charges. AOL spokesman Ed Adler
says that its operations did generate $651 million and argues that, under
standard accounting rules, special charges such as the settlement do not need to
be counted as expenses in the quarter in which they occur.

While investors often rip Tice apart on online bulletin
boards, he says they’re barking up the wrong tree: "We protect investors
with our analysis. The bad guys are the brokers that were promoting the
outrageous valuations of those companies," he argues. Tice recently went to
Washington to make his point. On June 14, he testified before a Congressional
committee chaired by Representative Richard Baker that is looking into the
erosion in the so-called Chinese wall that has traditionally shielded analysts
from investment-banking interests. Tice testified he believes the conflict of
interest between analysts and investment bankers encouraged stock market
speculation and pushed capital toward the tech sector at the expense of other
industries.

Tice attributes his skepticism to his Missouri upbringing.
"It’s a show-me state where we aspire to be as fiercely independent as
Harry Truman," says Tice who, like Truman, was raised in Independence.
These could just be the days for Give ‘Em Hell David Tice.

By Pallavi Gogoi in BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc